The Cashflow Statement is also called the Statement of Cashflows, and here we explain the meaning of, and look at what the statement shows us. It is one of the 3 main financial statements that businesses report on – the other 2 are Profit & Loss, and the Balance Sheet.
The cash flow statement reports the actual cash generated and used during the time interval stated in its heading. The period of time that the statement covers is chosen by the company, for example, “For the Three Months Ended 31 December, 2015” or “The Fiscal Year Ended September 30, 2016”. Most common is annual.
The cash flow statement actually uses data and the CHANGES between periods from the Profit & Loss and Balance Sheet, and organises and reports the cash generated and used in the following categories:
Operating, Investing and Financial activities
What the Cashflow Statement shows –
The profit & loss or Income Statement is prepared under the accrual basis of accounting, meaning the sales/revenues reported may not have been collected yet. Similarly, the expenses reported on the income statement might not have been paid. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors utilize this important financial statement.
Here are a few ways the statement of cash flows is used.
- The cash from operating activities is compared to the company’s net income (profit/loss). If the cash from operating activities is consistently greater than the net income, the company’s net income or earnings are said to be of a “high quality“. If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.
- Some investors believe that “cash is king”. The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are seen to be good for shareholder value.
- There are also some financial models that use the cash flow.
The statement of cash flows has four distinct sections:
- Cash generated from operating activities
- Cash generated from investing activities
- Cash generated from financing activities
- Supplemental information.
The differences in a company’s balance sheet accounts from one period to the next, will provide much of the needed information. The changes—or differences—in the account balances will likely be entered in one of the sections of the statement of cash flows.
Of the four sections of the statement of cash flows, those balance sheet accounts which affect each section include –
1. Operating Activities
This section reports the net income and then converts it from the accrual basis to the cash basis by using the changes in the balances of current asset and current liability accounts, such as:
- Accounts Receivable
- Prepaid Insurance
- Other Current Assets
- Notes Payable
- Accounts Payable
- Wages Payable
- Payroll Liabilities
- Interest Payable
- Income Taxes Payable
- Unearned Revenues
- Other Current Liabilities
Note – as well as using the changes in current assets and current liabilities, the operating activities section may list adjustments for depreciation expense and for the gains and losses on the sale of long-term assets/investments.
2. Investing Activities
This section reports changes in the balances of long-term asset accounts, such as:
- Long-term Investments
- Furniture & Fixtures
Investing activities involve the purchase and/or sale of long-term investments and property, plant, and equipment.
3. Financing Activities
This section reports changes in balances of the long-term liability and stockholders’ equity accounts, such as:
- Notes Payable (generally due after one year)
- Bonds Payable
- Deferred Income Taxes
- Preferred Stock
- Paid-in Capital in Excess of Par-Preferred Stock
- Common Stock
- Paid-in Capital in Excess of Par-Common Stock
- Paid-in Capital from Treasury Stock
- Retained Earnings
- Treasury Stock
Financing activities involve the issuance and/or the repurchase of a company’s own bonds or shares as well as short-term and long-term borrowings and repayments.
4. Supplemental Information
This section of the cash flow statement reports the amount of interest and income taxes paid as well as significant exchanges not involving cash. For example, the exchange of company shares for company bonds would be reported here.
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